RAX: Wells Ups to Buy Citing Reasons Hosting is Still a Growth Biz

By Tiernan Ray

Shares of data center hosting outfit Rackspace Hosting (RAX) are up $1.68, or almost 5%, at $37.79, after Wells Fargo‘s Gray Powell raised his rating on the shares to Outperform from Market Perform, and raised his “valuation range” to $46 to $49 from a prior $40 to $45, writing that his conversations with folks at privately held companies in the hosting industry have eased his fears that the hosting business is no longer a growth business.

According to Powell, “Many investors (ourselves included) have expressed concerns that cloud computing is cannibalizing the growth of managed hosting.”

But, “While cloud computing adoption has had some impact on managed hosting, our discussions with industry contacts lead us to believe that managed hosting is still very much a growth sector.”

Powell writes that his contacts point out some applications won’t run well on the kinds of cloud computing facilities provided by, for example,

All of our contacts stressed that many applications work better in dedicated environments than cloud environments. These include big data, compliance, legacy applications (anything Oracle), Hadoop, applications in need of high throughput, and workloads where server utilization is known. We highlight some thoughts on these topics below. Hadoop – AWS has a Hadoop service but it does not run on top of EC2. Often times, our contacts noted that customers want to run their own specialized version of Hadoop but that they cannot run a custom deployment on Amazon’s Elastic MapReduce platform. Given that Hadoop does not run well on EC2 (or any cloud service for that matter) customers tend to run it on dedicated infrastructure. PCI Compliance – Again, it is possible for customers to be PCI compliant in AWS’s cloud but it is difficult. A lot of CISO’s are cautious about signing off on PCI compliance in AWS environments and often times auditors feel more comfortable with dedicated environments. Compliance is one of the biggest drivers of dedicated hosting demand. High Throughput Applications – Generally, speaking our contacts firmly believe that low latency/high throughput applications need to be on dedicated infrastructure. For example – in a call we hosted with Internap (INAP) last week – the company highlighted that online gaming companies often require a dedicated environment because the performance variance or servers required in AWS can range from +10% – +30%. As a rough example – a company that needs to run 50 servers in AWS might find that they actually need to run an extra 10 servers just to reach their performance targets. Known server utilization – If the application’s utilization of a server is known and predictable then it is more likely that dedicated infrastructure will be more cost effective than the cloud. As an example, HubSpot is saving roughly 30-50% off their monthly bill by utilizing a hybrid managed hosting / cloud environment with RAX vs being 100% on AWS. In a colocation example, EQIX cited a case study where gamification company – Badgeville – was able to reduce monthly costs by 40% by moving from AWS to a colocation environment.

Powell also cites some customer wins by Rackspace in the face of cloud computing: “GoodData – Based in San Francisco, provides a cloud-based platform that enables more than 6,000 global businesses to monetize big data. Switched to RAX from AWS because they wanted a standardized platform in public, private, and dedicated environments.”

In addition, Rackspace’s own effort to diversify from hosting into cloud computing might provide some upside: “At current valuation levels combined with current street estimates – we believe RAX’s cloud business actually provides some optionality to the stock. Specifically, if RAX’s cloud strategy actually works – we think street estimates would likely move higher and the stock’s multiple would likely expand meaningfully.”

Powell concludes that after two quarters in a row of missing estimates, the Street consensus for Q2 and Q3 are achievable, given the Street seems to expect no “bounce back” whatsoever. He’s modeling $371.5 million in revenue and $114 million in Ebitda last quarter, and $385 million and $119 million this quarter, basically in line with consensus.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.